IFRS: Seriously Disconnects "Income" & Cash Flows

IFRS: Seriously Disconnects “Income” & Cash Flows

Al Rosen

? The Objectives/Purposes/Uses of financial reporting are fundamentally very separate, as between IFRS, and U.S. GAAP, as well as with the previous pre-IFRS Canadian GAAP. Widely different IFRS numbers (such as bottom-line “income”) can arise from each of the above; and, companies’ results can rarely be compared, for investment decisions. Where each of the reporting systems “makes sense” requires much thought.

Frankly, IFRS too often lacks credibility, because adequately-supporting measurement evidence is frequently lacking. IFRS financial statements surely appeal to swindlers because multiple choices of measurement often exist. Biases are easy to be added within IFRS. Investors can surely be fooled, especially by “non-cash IFRS income.”

Time dimensions being reported can be quite flexible under IFRS because it is a mixture of past period events, current period activities, and future “hoped-for” transactions. These three periods are frequently combined, and usually lack necessary explanations for investors.

???????????An especially-common situation of financial reporting diversity occurs when IFRS “income” is being bloated by these non-cash “value” increases. These were usually encouraged by weak, vague IFRS. For example, the present-year’s income statement could include management-chosen “value” increases on rented-out land and buildings. But, at the “income” calculation date no cash would have been received for the reported increased income “value.”

Automatically, therefore, huge potential interpretation confusion arises. Cash receipts on “value” changes may not appear for another 10-15-20 more years, to help in “supporting” long-ago declared IFRS increased “income.”

Thus, IFRS “income” figures tend to be poor-quality indicators of the cash-generating operating power of a company. Hence, potential borrowing and lending factors now have to be thoroughly analyzed by investors. Long-standing ratios used by lenders easily could need serious rewording. The IFRS-income separation-in-time, from actual dates of “cash-receipt” can easily mislead lenders about a company’s liquidity trend.

A variety of misinterpretations can also arise from IFRS non-cash “income” dollars being disconnected in time and amounts with actual operating cash, being received frequently. For instance, IFRS reporting tends to allow financial tricksters to combine dollars in two of the three “sections” of Cash Flow Statements. Such shenanigans are designed to try to cover-up the extent of the dollar discrepancy between reported IFRS (including non-cash) “income,” and actual receipt of cash seriously needed to operate the company day-to-day. Unwise cash management, in turn, can lead to cash mis-management, and eventual bankruptcy. Borrowing requires having assets to pledge as security plus interest must be paid.

Examples would be the many situations where investors in a company have allowed the company’s stock exchange price per share to become too closely linked to its reported, but bloated, IFRS “income.” Often such occurs when dividends per share have become well in excess of cash receipts from company expectations (but not being alarming enough when being compared to IFRS’ reported “income.”)

Our experience as investigative accountants indicates that many investors do NOT understand the dangers of non-cash IFRS “income.” Having to borrow frequently can be dangerous.

Investors thus have to carefully read Cash Flow Statements. Cash Flow Statements have three main “sections” :

*??????operating cash flow, arising from sales/services activities (being a main role of a business);

*??????financing of the company (cash received by borrowing, or selling more equity/shares);

*??????investments (assets such as land, buildings, equipment, and needed intangibles such as patents).

Enough operating cash flow is typically needed each year to acquire modern operating (replacement) facilities, encourage innovation, pay dividends, and similar. (Being a worthy competitor in the marketplace is obviously a necessity. Re-investment is required to stay competitive. Cash has to be spent; what are its sources? Not non-cash “values.”)

A too-frequently-seen swindle, designed to hide the reported dollar “income” (versus “operating cash flow”) “discrepancy” involves falsely combining sales of some “investment equipment” with regular “cash from the company’s operations.” A company is not in the principal business of selling its needed cash-generating production assets. Thus, cash proceeds received on sales of investment assets should usually be referred to as “disinvestments.” They are definitely NOT “operating cash inflows.” Indeed, selling investment assets could lower future “operating cash flows,” and their sale should raise concerns.

Nevertheless, tricksters include such proceeds from investment sales as part of “cash from (regular) operations.” (Sales of scrap inventory have to be separated from sales of investment assets.) This trick helps to narrow the discrepancy dollars between IFRS “income” and operating “cash receipts,” but only temporarily.

However, significant consequences of the above arise in some industries, especially such as real estate renters. Building are NOT inventory for quick sale. Properties for rent surely are part of the long-term “Investments” of the entity. “Buildings for monthly or annual rent” are not primarily purchased so as to quickly “resell.” Surely, the buildings for rent are similar to the machinery that is used to produce the company’s longer-term “products for sale.”

Accordingly, when IFRS permits rental companies to frequently “revalue” such rental assets, AND, include the “value” changes in annual or periodic IFRS “income” a “strange IFRS contradictory muddle” occurs. “Operating Cash Flow” (which includes monthly rental receipts) and disposals of longer-term Investments (which are not likely to be annual events) somehow, under IFRS, become weird, inappropriate identical twins. [It is this type of readily-available alternative reporting treatment that makes a mockery of the IFRS claim of seeking a worldwide reporting system.

IFRS’ strange definitions cause considerable inconsistencies, which were previously covered in our LinkedIn articles. [IFRS is too conceptually muddled to be “repairable.”] (See also “Avoiding Swindlers,” by Al Rosen; 2022 book, for other examples.)

Those who still believe that IFRS reporting can become a worldwide system of financial standards ought to address its long list of very serious weaknesses. Perhaps their starting point may be watching marijuana grow; and then following IFRS “rules” by recording IFRS “income” from growth, daily. Several portions of IFRS are simply inconsistent and absurd.

When IFRS’ reported “income” is far removed in dollars from available cross-checks, such as with actual operating cash receipts, an enormous warning signal has been raised. The credibility of IFRS presents a complex challenge, when “investments” and operating assets are treated as “equals.”

Meanwhile, the swindlers certainly cheer for retaining IFRS, at least until they have bankrupted most investors. Governments in Canada should never have accepted IFRS. Ministries of Investor Protection have to be established promptly, to gather facts and curtail falsehoods. Procrastination will not cure the many ills of IFRS.